Shares of Huntington Ingalls Industries, Inc. (HII, Financial) have climbed more than 32% since I last discussed the company in mid-November of 2020.
While my bullish thesis on the stock has played out much quicker than I thought, I still believe that the stock has more room to the upside. Let's take a look at why.
Recent results
Huntington Ingalls last reported earnings results on May 6. The company generated revenue of $2.28 billion for the quarter, an improvement of just under 1% and $50 million above what Wall Street analysts had expected.
Adjusting for pension costs, earnings per share of $3.56 was a 46.5% increase from the prior year and 93 cents above estimates. The companywide operating margin fell 305 basis points to 6.5%, mostly due to a less favorable operating pension adjustment.
Ingalls Shipbuilding reported revenue of $649 million, which was a 3.2% improvement from the previous year. This segment benefited from higher revenues in the Arleigh Burke-class DDG program due to an increase in volumes, but was partially offset by lower volumes for Cost Guard cutters. Revenues for amphibious assault ships was comparable to the prior year. The operating margin improved 320 basis points to 14%, mostly on account of higher risk retirement for the company's amphibious assault ship Bougainville that is in the midst of being constructed.
Newport News Shipbuilding grew 4.9% to $1.4 billion due to strength in aircraft carriers, naval nuclear support services and submarines. Huntington Ingalls saw higher volumes for the Enterprise aircraft carrier as well as refueling and complex overhaul on several ships. Demand was higher for support services for carrier and submarine fleets. Also in submarines, this segment had an increase in workloads for the Columbia-class and Virginia-class programs. The operating margin fell 50 basis points to 6.6% as higher risk retirement in Virginia-class Block IV boats was offset by lower risk retirement for refueling and complex overall for aircraft carriers.
Technical Solutions suffered a 18.3% decrease in revenues. Fortunately, at $259 million, this segment contributes a small portion of total revenues. Technical Solutions was lower on account of Huntington Ingalls divesting its oil and gas business as well as its San Diego Shipyard. This segment also saw weakness in Defense and Federal Solutions. On the plus side, the operating margin of 2.7% compared favorably to -2.2% in the previous year.
The company ended the first quarter with total assets of $8.2 billion, including current assets of $2.4 billion and cash and equivalents of $407 million. In comparison, total liabilities came to $6.2 billion with current liabilities of just under $2.3 billion. Huntington Ingalls has $1.7 billion of long-term debt.
Guidance
Huntington Ingalls reaffirmed guidance for the full year. The company continues to expect shipbuilding revenue of $8.2 to $8.4 billion with Technical Solutions adding approximately $1 billion. The company expects overall revenue to be comparable to last year's revenue of $9.36 billion. Shipbuilding margin should be between 7% to 8%, in-line with prior guidance. According to Yahoo Finance, analysts expect Huntington Ingalls to report adjusted EPS of $13.15 in 2021, which would be a 32% increase from 2020 levels if achieved.
Takeaways
One of the main reasons I remain so bullish on the aerospace and defense sector is the sheer amount of capital that governments are spending on defense. The U.S. alone is spending more than $700 billion on defense this year. Aerospace remains weak, especially in commercial, due to Covid-19, but those contractors with a focus on defense are holding up much better.
With a market capitalization of $8.6 billion, Huntington Ingalls is one of the smaller names in the space, but its focus on defense is paying off.
Another factor that attracts me to Huntington Ingalls in particular is the length of contracts for ship production. It takes multiple years to complete a full order. As an example, the company's Block V Virginia-class contract that was agreed to in fiscal year 2019 runs through the end of fiscal year 2023.
Further, the contracts are structured in a way that puts the government on the hook for cost overruns. Shipbuilders tend to experiment with new technology on lead ships, which could impact the total number of ships that it produces. However, Huntington Ingalls has cost-reimbursable contracts with the Navy, so the company can recover some of the unforeseen production costs and still be able to maintain profit margins.
Lastly, Huntington Ingalls has a massive backlog. The company received more than $5 billion in new orders during the last quarter, giving Huntington Ingalls a backlog of nearly $49 billion, a 6% improvement sequentially. This backlog, a new company record, gives Huntington Ingalls more than five years' worth of work using 2020 revenue totals. While some of this backlog is not yet funded, the company and investors have much clarity on future revenues.
With this much work, with much of the contracts guaranteed, Huntington Ingalls will likely continue to see solid growth.
Valuation
Currently trading at $214, Huntington Ingalls has a forward price-earnings ratio of 16.4 using analyst estimates. The stock has had an average price-earnings ratio of just over 14 since being spun off from Northrop Grumman (NOC, Financial) in 2011, so shares are expensive compared to their historical valuation.
Still, Huntington Ingalls isn't overtly expensive compared to the past, and it also trades below its intrinsic value as calculated by the GuruFocus Value chart.
Huntington Ingalls has a GF Value of $245.97, resulting in a price-to-GF-Value ratio of 0.87. Rising to meet the GF Value would result in a return of nearly 15%.
Investors are also receiving a dividend yield of just over 2% at the moment that is superior to the average yield of 1.4% for the S&P 500. The dividend, which has been increased for eight consecutive years, could push total returns to the high-teens range.
Final thoughts
Huntington Ingalls has performed very well since the last time I looked at the company. Most recent quarterly results were solid, especially in shipbuilding, and the company has a healthy backlog of work.
Though the 30%+ rally since last November has sapped some of the gains that I felt were possible, investors buying today could still see excellent returns. As such, I continue to believe that Huntington Ingalls is a buy.
Author disclosure: the author has no position in any stocks mentioned in this article.
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